Is There An Opportunity With Beijing Tong Ren Tang Chinese Medicine Company Limited’s (HKG:3613) 20.88% Undervaluation?

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In this article I am going to calculate the intrinsic value of Beijing Tong Ren Tang Chinese Medicine Company Limited (HKG:3613) by taking the foreast future cash flows of the company and discounting them back to today’s value. I will use the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in February 2019 so be sure check out the updated calculation by following the link below.

See our latest analysis for Beijing Tong Ren Tang Chinese Medicine

The calculation

I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow estimate

2019 2020 2021 2022 2023
Levered FCF (HK$, Millions) HK$532.00 HK$694.10 HK$819.04 HK$958.27 HK$1.11k
Source Analyst x1 Analyst x1 Est @ 18%, capped from 18.07% Est @ 17%, capped from 18.07% Est @ 16%, capped from 18.07%
Present Value Discounted @ 8.4% HK$490.77 HK$590.69 HK$643.00 HK$694.01 HK$742.66

Present Value of 5-year Cash Flow (PVCF)= HK$3.2b

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.4%.

Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = HK$1.1b × (1 + 2%) ÷ (8.4% – 2%) = HK$18b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = HK$18b ÷ ( 1 + 8.4%)5 = HK$12b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is HK$15b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of HK$17.92. Compared to the current share price of HK$14.18, the stock is about right, perhaps slightly undervalued at a 21% discount to what it is available for right now.

SEHK:3613 Intrinsic value, February 22nd 2019
SEHK:3613 Intrinsic value, February 22nd 2019

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Beijing Tong Ren Tang Chinese Medicine as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.4%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For 3613, I’ve compiled three relevant aspects you should look at:

  1. Financial Health: Does 3613 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does 3613’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of 3613? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St does a DCF calculation for every HK stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.